The US economy finally seems to be climbing out of the deep hole it entered during the global financial crisis. Unfortunately, Europe, the other epicenter of crisis, cannot say the same. Unemployment in the eurozone is stalled at almost twice the US level, while inflation is far below the official target and outright deflation has become a looming risk.
Investors have taken notice: European interest rates have plunged, with German long-term bonds yielding just 0.7 percent. That is the kind of yield we used to associate with Japanese deflation, and markets are indeed signaling that they expect Europe to experience its own lost decade.
Why is Europe in such dire straits? The conventional wisdom among European policymakers is that we are looking at the price of irresponsibility: Some governments have failed to behave with the prudence a shared currency requires, choosing instead to pander to misguided voters and cling to failed economic doctrines. And if you ask me (and a number of other economists who have looked hard at the issue), this analysis is essentially right, except for one thing: They have got the identity of the bad actors wrong.
For the bad behavior at the core of Europe’s slow-motion disaster is not coming from Greece, Italy or France. It is coming from Germany.
I am not denying that the Greek government behaved irresponsibly before the crisis, or that Italy has a big problem with stagnating productivity. However, Greece is a small country whose fiscal mess is unique, while Italy’s long-run problems are not the source of Europe’s deflationary downdraft. If you try to identify countries whose policies were way out of line before the crisis, have hurt Europe since the crisis and refuse to learn from experience, everything points to Germany as the worst actor.
Consider, in particular, the comparison between Germany and France.
France gets a lot of bad press, with much talk in particular about its supposed loss of competitiveness. Such talk greatly exaggerates the reality; you would never know from most media reports that France runs only a small trade deficit. Still, to the extent that there is an issue here, where does it come from? Has French competitiveness been eroded by excessive growth in costs and prices?
No, not at all. Since the euro came into existence in 1999, France’s GDP deflator (the average price of French-produced goods and services) has risen 1.7 percent per year, while its unit labor costs have risen 1.9 percent annually. Both numbers are right in line with the European Central Bank’s target of slightly under 2 percent inflation, and similar to what has happened in the US. Germany, on the other hand, is way out of line, with price and labor-cost growth of 1 and 0.5 percent respectively.
And it is not just France whose costs are just about where they ought to be. Spain saw rising costs and prices during the housing bubble, but at this point, all the excess has been eliminated through years of crushing unemployment and wage restraint. Italian cost growth has arguably been a bit too high, but it is not nearly as far out of line as Germany is on the low side.
In other words, to the extent that there is anything like a competitiveness problem in Europe, it is overwhelmingly caused by Germany’s beggar-thy-neighbor policies, which are in effect exporting deflation to its neighbors.
However, what about debt? Is non-German Europe not paying the price for past fiscal irresponsibility? Actually, that is a story about Greece and nobody else. And it is especially wrong in the case of France, which is not facing a fiscal crisis at all; France can currently borrow long-term at a record-low interest rate of less than 1 percent, only slightly above the German rate.
Yet European policymakers seem determined to blame the wrong countries and the wrong policies for their plight. True, the European Commission has floated a plan to stimulate the economy with public investment — but the public outlay is so tiny compared with the problem that the plan is almost a joke. Meanwhile, the commission is warning France, which has the lowest borrowing costs in its history, that it may face fines for not cutting its budget deficit enough.
What about resolving the problem of too little inflation in Germany? Very aggressive monetary policy might do the trick (although I would not count on it), but German monetary officials are warning against such policies because they might let debtors off the hook.
What we are seeing, then, is the immensely destructive power of bad ideas. It is not entirely Germany’s fault — Germany is a big player in Europe, but it’s only able to impose deflationary policies because so much of the European elite has bought into the same false narrative. And you have to wonder what will cause reality to break in.
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